HALISTER1: EU RATES ROUNDUP: Long Duration, Fade Rally in Front-end

EU RATES ROUNDUP: Long Duration, Fade Rally in Front-end

(Bloomberg) -- Post-Brexit vote, analysts look for further BOE easing, like longs in front-end of U.K. curve; most maintain a bullish, flattener bias on German curve.
  • Citi, Deutsche bank and SocGen suggest front-end of EUR rates curve too aggressively priced for ECB rate cuts, given negative impact on banks, recommend fading
  • Citi (strategists including Harvinder Sian)
    • Leave vote poses greater economic risks to European recovery, markets will factor in the location and size of the “ECB policy put”
    • ECB to be reactive if BTPs yields over 2%; rate cuts do little here but ECB has firepower in current QE flexibility, to calm markets; recommend buying in any panic sell-off
    • Bund rally can be sustained given ECB intervention, negative convexity is heightened; 10Y bund at -0.15% sees ECB hit 33% limit in July, would limit rally but implies flatter curves
    • ECB to remain in easing mode, see extension of QE from March 2017 to at least Sep. 2017; market priced for more rate cuts too aggressive given vulnerability of banks to lower rates
      • See mid curve Euribor Sept put strikes as attractive and cheap short (0RU7P 100.25) at 1 cent
    • See 10Y Gilts below 1%, target 0.9%; BoE’s first response will be liquidity provision, rate cuts, then QE may follow
      • Like QE trades such as buying 30Y gilt swap spreads, although look for better entry levels
  • JPMorgan (strategists including Fabio Bassi)
    • Post-Brexit vote, see BOE cutting rates by 50bps by end- August; ECB to cut deposit rates by 10bps to -0.50%, extend QE purchases by 9-months to end-2017 at Sept. meeting
    • Lower growth, inflation, more ECB easing justify sub-0bps 10Y Bund yields, 30Y yields have further to go: re-enter 10s30s flatteners
    • Nov. 16 MPC OIS cheap; recommend long 10Y gilts, forecast yield at 0.85% by 3Q
    • Remain neutral on intra-EMU spreads, don’t see good risk-reward; maintain 2Y shorts in Spain vs Italy; take profit on front end Brexit hedges such as long Sept. 16 ECB OIS
      • Recommend fading current spike in front-end implieds; Schatz implieds close to highs seen during Oct. 2015 when ECB easing expectations at its peak, next ECB meeting is still about a month to go (July 21), don’t expect policy action then
  • Morgan Stanley (strategists including Anton Heese)
    • G4 rates have further to go, barely below last week’s lows in yield; best value in belly of curve due to potential for further central bank easing, attractive carry & roll
      • Recommend long 5y USTs, 5y Gilts, 5y JPY swaps, EUR 5y5y
    • Expectations of further easing may persist, but EUR front-end is more demandingly priced; recommend being short it vs U.K. front-end; long 07/2018 Gilt vs 06/2018 Schatz at 91bps
    • Closed trades suggested heading into the EU referendum including, long 11/2019 UKTi breakevens, received 2y2y GBPUSD XCCY
  • Deutsche Bank (strategists including Francis Yared)
    • 10Y BTPs which sold off less than anticipated on Brexit vote; political contagion to Eurozone is key transmission channel for more sustained, significant risk off
    • Current pricing of further cuts to depo rate by ECB is questionable given increased focus on health of banking system; credit easing likely to be more effective
    • Maintain the long GBP 10Y breakeven (despite potential underperformance in a risk off, should benefit from a weaker currency)
    • ECB unlikely to cut depo rate further, recommend short EUR 5Y swap, March 17 Eonia; maintain BTPs 10s30s flatteners as should perform in risk off, relatively resilient in a rally
    • In U.K., recommend receiving Sept. MPC dated Sonia as market is pricing less than one full rate cut at ~18bps
      • Exit paying EUR5s10s20s, paying USD5s10s30s
  • RBS (strategists including Giles Gale)
    • 10y bunds to press to -0.4%, 30y bunds toward 0%; key for periphery is if this shock is managed by policymakers; expect BTPs to be backstopped by domestic money at 2% if not before
    • Revised down U.K. growth forecasts post-Brexit vote, MPC to put more emphasis on expected downside demand shock than on near-term upside inflation risks from the pound’s depreciation
      • Expect two relatively early 25bp cuts in Bank Rate to 0% (in July, August meeting), where MPC has indicated they believe the floor is; plenty of verbal intervention likely in meantime
      • ECB may “err on the side of caution”, accelerate monthly asset purchases, cut interest rates again possibly as soon as July meeting
    • In terms of trades, maintain long 10Y bunds, Gilts, 10s30s Germany flatteners, long U.K. July Sonia: MORE
  • SocGen (strategists including Vincent Chaigneau)
    • Investors should flee risk assets, sell the dead cat bounce; not a Lehman moment, but slow-burning political shock, risks undermining global economy when it is dangerously feeble
    • Treasuries, bunds yields still well above post-Brexit targets, recommend run long G4 duration, USTs a preference
    • Don’t expect much follow through of rally in front-end EUR; market price 20bps of cuts by late-2017, at least 10bps too much given negative side effects; fade via 2s10s flatteners
    • Related uncertainty, negative convexity effects of ECB’s PSPP justify longs in EUR long-end gamma, recommend conditional 10s30s bull flatteners
    • Brexit should lead to steeper U.K. curve; front-end expected to move to pricing 25-40bps of cuts as growth expectations collapse; 5y yields to outperform, recommend 5s20s steepeners
    • Gilts are rich-end of scale vs USTs, given credit, currency risks, less attractive to overseas investors; recommend selling 10Y Gilts vs USTs at -46.5bps, target 35bps, stop -52bps
Alert: HALISTER1
Source: BFW (Bloomberg First Word)

Tickers
2539Z GR (European Central Bank)

People
Anton Heese (Morgan Stanley)
Fabio Bassi (JPMorgan Chase & Co)
Francis Yared (Deutsche Bank AG)
Giles Gale (Royal Bank of Scotland Group PLC)
Harvinder Sian (Citigroup Inc)

Topics
BFW EU Rates Analyst Wrap

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